What to make of earnings season

Though market watchers make ado about earnings season four times a year, Dave Sandstrom advises long-term investors to pay more attention to forward-looking indicators. He tells Joel Dresang in a Money Talk Video that relying on earnings reports can be like driving too much with the rearview mirror.

Joel Dresang: Dave, we know that earnings and interest rates are what move stock prices in the long run. Let’s talk about earnings today, and specifically about the earnings season. First of all, remind us why earnings are so important.

Dave Sandstrom: Well, I think it boils down to the question of why do you own stocks in the first place? When you purchase stocks, you’re buying the opportunity to participate in the future earnings stream of that corporation. Now remember, whether you’re buying the stock for a dividend payment or for capital appreciation, earnings growth is really what’s going to be critical. And really, earnings growth is the main catalyst for stock prices to go up.

Joel: So, we have earnings season four times a year. January it begins, April, July, October. That’s when publicly held companies report on their revenue and their earnings. What do you watch in those reports?

Dave: Well, the reports are an effective tool for evaluating what that company did in the prior quarter, especially looking at analyst estimates and how they did maybe against other companies. And they give you a pretty good short-term trend identification.

But remember, you’re looking backwards at past results. What we’re really interested in is where is the future earnings going?

Joel: And where do you get that information?

Dave: Well, in those reports, you will get some forward guidance from the companies themselves, and then also some from the analysts that are following these companies. And that’s really what’s important to the future of stock prices is, is where those future profits and earnings are going to be.

Joel: And those reports are on individual companies. What if I own my stocks through mutual funds?

Dave: So, the mutual fund is going to diversify your risk, and the fact that you own many companies takes some pressure off of those individual earnings reports. Those earnings reports can still identify larger market trends, whether we’re seeing a kind of a repeated pattern of growth in earnings, or a reduction in earnings, maybe some broader trends in the markets or in market sectors and how those performances are going, which is certainly critical to the performance of your mutual funds.

Joel: What do you use all that information for?

Dave: I think as you’re designing portfolios for the future – and again, we’re not talking about market timing or making abrupt changes from these reports – but it does give you maybe some guidance as to where you’re going to position yourself longer term, and some of those reports can definitely have an impact on that.

Joel: So, as a long-term investor with a balanced, diversified plan, what should I be doing about earnings season?

Dave: I think what’s important is that we’re forward looking. Keep your eye on the horizon. Looking backwards at earnings in the past is kind of like driving looking through the rearview mirror. I think it’s important for an investor to develop a plan, stick to it and then reallocate when those balances grow outside of your comfort zone.

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